Loan Basics. How you can benefit from rate cuts

Over the past week, banks have been slashing their lending rates by a steep 70-90 basis points. If you were planning to shop for a home loan, this is the time to lock into some attractive rates. However, old borrowers have little to cheer, with their lending rates staying put for now. Banks, though, are offering to switch your existing loan to cheaper rates. Here’s how borrowers can benefit:

Since April last year, lending rate on floating rate home loans have been pegged against a new benchmark — the marginal cost of funds-based lending rate (MCLR), instead of the erstwhile base rate. Under the new norms, banks will add a spread to the MCLR, to arrive at the loan rate.

Post-demonetisation, banks have been flush with deposits and have hence resorted to slashing deposit rates. Given that MCLR uses the latest rates offered on deposits for its computation, borrowing rates are on a descent.

SBI, which was the first to slash rates, has lowered its one-year MCLR from 8.9 per cent in December 2016 to 8 per cent in January 2017. ICICI Bank, has reduced its MCLR by 70 basis points. Many other banks have also followed suit.

For new borrowers, SBI’s home loan at a spread (mark-up over MCLR) of 65 basis points currently, is the best deal for now. The effective rate for loans up to ₹75 lakhs is now 8.65 per cent, down from 9.15 per cent in December. This means your EMI shrinks by ₹1,482 on a ₹50 lakh loan for 15 years. And you save around ₹2.6 lakh of interest over the entire tenure of loan.

While rates will continue to fall, steep cuts are unlikely to happen again. Hence, it may be the right time to lock into some of the best deals. Apart from SBI, ICICI Bank and Housing Development Finance Corporation (HDFC) offer a competitive 8.7 per cent.

Sadly, old borrowers — those who have taken loans against the erstwhile base rate prior to April 2016 — have not had much respite yet. This is because, while banks have been slashing MCLR, they have not lowered their base rate. For example, after holding its base rate at 9.3 per cent from October 2015, SBI has only now reduced it marginally to 9.25 per cent. This is much higher than its one-year MCLR at 8 per cent.

Hence, old borrowers still pay 9.5 per cent interest (spread of 25 basis points over base rate). To help them, banks, including SBI, are allowing borrowers to switch into the new MCLR regime, at a cost.

Under the first option offered by SBI, borrowers can switch into MCLR, free of charge, but they will be locked into old rates for a year, before MCLR becomes applicable. Old borrowers paying 9.5 per cent currently will continue to be charged this rate for a year. After one year, their loans will be priced at the applicable one-year MCLR then. But there is a small hitch. Since these borrowers have moved into the MCLR framework, paying an effective loan rate of 9.5 per cent for one year would mean that they are charged a spread of 150 basis points over the current one-year MCLR at 8 per cent.

This spread will continue after a year too. If we assume that MCLR falls to 7.5 per cent, then the borrower will be charged 9 per cent (7.5 per cent plus spread of 150 basis points). This will still be higher than what new borrowers would pay — 8.15 per cent (7.5 per cent plus spread of 65 basis points). The higher spreads can hurt even more when rates rise.

Borrowers can hence give this option a miss.

Under the second option, SBI charges 0.5 per cent of the loan outstanding (minimum of ₹10,000) for switching immediately to the new MCLR rates. In this case, old borrowers will be charged the lower rate of 8.65 per cent (applicable to new borrowers).

If you have an outstanding loan amount of ₹50 lakh with a remaining tenure of 15 years, you will recover the switching cost of ₹25,000 in about 17 months, through your savings in EMI (lending rate reduces from 9.15 per cent to 8.65 per cent). Hence it makes sense for you to make the switch.

Remember though that the benefit shrinks with lower amount of loan outstanding and tenure. Say for instance, you have an outstanding loan of ₹20 lakh for five years. Then, the entire savings on interest is just around ₹29,000 for which you will have to cough up ₹10,000. Hence it will make less sense to switch if you are at the fag end of your loan tenure.

Each bank or HFC may however offer different options. Do take note of them before you decide to switch. While ICICI charges a fee similar to SBI, HDFC (that pegs its home loan rates against retail prime lending rate) will charge borrowers up to ₹5,000 (plus taxes) for moving to the recently revised 8.7 per cent rate.

If you are looking to switch from one bank to another, remember that you have to foreclose your loan, and then approach a new bank for a fresh loan. Here, banks usually charge a processing fee, which ranges from 0.5 to 1 per cent of the loan. There could be an additional service charge too. But do look for waivers offered by banks.